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For the last few years, the government has proposed limitations on tax-deferred retirement savings that eligible individuals can contribute to their 401k savings plans. For Fiscal Year 2014, the current administration has again proposed a cap on these contributions. This cap limits the amount that can be invested in a 401k and imposes a maximum on the tax-savings that investors can reap by making these contributions.
Who Does This Affect?
The proposed cap for FY 2014 stands at $3 million over a person's lifetime, or about $205,000 per year. While this may sound like an unreachable amount to some investors, it really isn't that difficult to accomplish if a person invests wisely. Many experts say that a person who begins making contributions into a 401k starting at age 25 can easily hit this cap before they are eligible to retire.
This may seem confusing, especially in light of the current limits on contributions to a 401k. Employee contributions to a 401k are limited to $17,500 per year. However, with employer matching contributions and company profit-sharing contributions, a worker is easily able to reach and even exceed the $205,000 per year cap that the government has proposed. All contributions made to a 401k are free from taxation, so while this helps employees, it hurts the government.
The affect of this cap is far-reaching. It is estimated that there were more than 20.6 million 401k accounts in existence at the end of FY 2012. Over 0.03% of these accounts will be affected by the cap. Since some investors hold more than one 401k account, experts predict that 0.06% of all account holders will be affected by the limitations.
There are negative consequences on either side of the coin. By placing a cap on tax-free 401k contributions, the government increases tax revenue paid by taxpayers and helps its bottom line. While it is unlikely that we will see the reduction or resolution of the national debt problem in our lifetimes, every little bit helps. The current administration also claims that these limitations are necessary because some individuals have saved more than is reasonably necessary to fund their retirement lifestyles.
However, putting a cap on tax-free 401k contributions takes away the incentive for people to invest and prepare for their future. And with the shaky economy, this cap can hurt investors and cause them to look for other ways to invest their money and prepare for their future. With the uncertainty surrounding the availability of Social Security retirement benefits, workers should be encouraged to take charge of their own futures and invest wisely so they can support themselves when it's time to retire.
In addition, tax issues and investing are already complicated enough. There are many loopholes and pitfalls for investors and taxpayers, and tax advisors and preparers have mountains of information to keep abreast with. Placing more limitations on investments and tax benefits just adds to more issues with tax returns and audits. Many critics take issue with the government telling people how much they need to fund their retirement years and live comfortably, so this has become a huge battle.
As with other areas of the tax code, these rules are constantly changing. It is important to retain the services of a certified tax professional to help you make the most of your income.